BHP Billiton Ltd (BHP) Recommendation: Accumulate (previously Hold) 2 February 2010 Recommendation upgrade. Prefer BHP to Rio Tinto. At $39.20/share (open on 2 February 2010: $40.49), our recommendation for BHP is upgraded from Hold to Accumulate following the fall in BHP’s share price, continuing supportive economic releases (eg China data, US ISM manufacturing index) and our previous advice on 21 January 2010 that we prefer BHP to Rio Tinto (RIO, $67.41, Hold). This latter view was based on the respective iron ore sales mix advised by both companies in their quarterly reports: (BHP has 46% of iron ore sales based on shorter term reference pricing); RIO’s outperformance relative to BHP over the past six months; and, in the event that there are substantial curbs to credit growth in China, BHP has less downside risk relative to its peer group (due to its unrivalled balance sheet strength, operating cash flow). In its iron ore business, BHP (on 29 January 2010) has pre-approved US$1.93 billion of early capital expenditure for the company’s Rapid Growth Project 6 (RGP6) in the Pilbara. BHP’s December Quarter Production Report (released 20 January 2010) was mixed, but had some key positive features (primarily iron ore sales pricing basis; also iron ore production, copper concentrate provisional pricing). For the half year ended December 2009, 46% of BHP’s WA Iron Ore shipments were based on shorter term reference pricing (quarterly, spot or index pricing basis), which was higher than we would have expected. We upgraded our current year earnings estimate for BHP by 5% to US$10.9 billion, largely due to the change in iron ore sales mix. Overall, we remain somewhat cautious on the outlook given: base metals prices have been - and still are - above levels that could be justified from fundamentals; and recent cautious comments from both BHP and RIO. Any further strengthening in the US$ relative to the Euro (on concern over sovereign debt issues) is likely to constrain base metals prices. Share price: $39.20 Market Capitalisation: A$218b Year ending 30 June 2008 2009 2010 2011 2012 Act Act Est Est Est Attributable Profit (US$m) 1 15,368 10,722 10,877 15,292 17,194 EPS (UScps) 274.9 192.7 195.6 275.0 309.2 DPS (USc) 70.0 82.0 86.0 92.0 96.0 Attributable Profit (A$m) 17,181 14,373 12,086 16,991 20,968 EPS (Acps) 307.3 258.3 217.4 305.6 377.1 P/E ratio (x) 12.8 15.2 18.0 12.8 10.4 DPS (c) 78.84 110.0 95.6 102.2 117.1 Franking (%) 100% 100% 100% 100% 100% Net Yield (%) 2.0% 2.8% 2.4% 2.6% 3.0% Assumptions $A/US 0.895 0.746 0.900 0.900 0.820 Aluminium (US$/lb) 1.21 0.85 0.87 0.91 0.95 Copper (US$/lb) 3.50 2.23 2.95 3.15 3.10 Oil (WTI US$/bbl) 97 68 74 87 89 1 2009: Attributable Profit including exceptional items: US$5,877m. BHP Billiton Ltd Iron Ore – Early approval for RGP6 Other Business Units BHP has pre-approved (on 29 January 2010) US$1.93 Positive production performances included: record billion (BHP Billiton share US$1.73 billion) of early quarterly iron ore production, up 8% compared to capital expenditure for the company’s Rapid Growth the September quarter; a strong petroleum Project 6 (RGP6). RGP6 is expected to increase production performance; and recoveries in nickel and installed capacity at the company’s WA Iron Ore manganese ore and alloy output. However, assets to 240mtpa during the 2013CY. metallurgical coal production was down 5%. The funding will allow early procurement of long lead Total Petroleum Production in the December quarter time items and detailed engineering to continue the was down 7% against a strong previous quarter due expansion of the inner harbour at Port Hedland, lower seasonal demand in eastern Australia and progress rail track duplication works and expand the planned downtime at Mad Dog and Atlantis in the Jimblebar mining operation. The approval for the Gulf of Mexico. However, December half output of balance of the RGP6 capital will be considered during 79.75 million boe was up 17% on the pcp due to the the second half of the 2010 calendar year (likely total ramp up of Shenzi (USA), strong reservoir cost: >US$4b on a 100% basis). performance from Atlantis and no weather related interruptions. As part of the binding agreements on the proposed iron ore production JV, Rio Tinto will have the option The finalisation adjustment (for 2009FY copper to participate in RGP6 by paying its share of invested concentrate sales) plus the provisional pricing impact capital; with this decision being made after the Joint for copper sales as at 31 December 2009 will increase Venture transaction is completed (estimated in the BHP’s half year earnings by US$467m. December half 2010). Nickel production was higher than all comparative periods (December quarter: +38% compared to the December Quarter Production Report September quarter). Iron Ore Manganese ore and alloy production is ramping up with improved demand, which will also benefit OM BHP reported record quarterly iron ore production, up Holdings (OMH, $2.00, Accumulate). 8% compared to the September quarter (RIO iron ore production on same basis: -1% including IOC) Metallurgical Coal production was down 5% for the through the utilisation of rail and port infrastructure quarter and perhaps weaker than anticipated, improvements as part of Rapid Growth Project although quarterly shipments were up in response to (RGP) 4. Ramp up of RGP4 is continuing with full strong demand. capacity expected to be achieved by the end of BHP’s announcement of US$240m pre-approved calendar year 2011. Including RGP4, BHP’s full expenditure on the Jansen Potash Project in installed capacity across the WA Iron Ore operations Saskatchewan, Canada (final investment decision: late will be 155mtpa (100% basis). 2011) should reduce/dispel speculation regarding a For the half year ended December 2009, 54% of possible large BHP acquisition in this space eg BHP’s WA Iron Ore shipments were based on annually Potash Corp of Saskatchewan (>US$34 billion) or agreed pricing (2009 fines benchmark price US$60/t Mosaic. FOB, 62% Fe), with the remainder sold on shorter term reference pricing ie 46% of sales were on a In its brief market/outlook comments, BHP noted quarterly, spot or index pricing basis (spot iron ore the strong price recovery during the quarter across the commodity suite, driven by demand in China and fines price, 15 January: US$135/t cif China). The restocking in the developed world. Going forward, proportion of sales on shorter term reference “the speed of recovery in the developed economies pricing is higher than we would have expected (and remains uncertain, particularly considering the compares with 30% of sales reported in July). eventual withdrawal of government stimulus. In We estimate that, for a six month period (December China the impact of measures to control loan growth and March quarters) BHP’s earnings would benefit will add another future variable” (noted in our PWW by ~US$800m with this pricing mix relative to the last week). “Consequently we expect some degree 2009 contract or provisional prices (or ~US$278m of volatility in the short term outlook for our compared to 30% of sales on shorter term commodities.” We have a similar view. reference pricing). This was the key positive for earnings estimates in the report. BHP Billiton Ltd Final Result Full year attributable profit, excluding exceptional Profit/(Loss) US$m 2007 2008 2009 items, of US$10.722 billion (2008: US$15.368b) Revenue (incl jv & assoc) 47,473 59,473 50,211 was slightly above market expectations. Underlying EBIT 20,067 23,497 18,214 EBIT - from operations 18,401 24,145 18,214 Underlying EBIT for 2009 (refer to chart below) was Net interest expense -390 -662 -543 down 25% to US$18.2b (2008: US$24.3b) due to Profit before tax 18,011 23,483 17,671 the following influences: Total tax expense -4,515 -7,521 -6,432 Lower sales volumes (largely in Base Metals Outside equity interests -80 -572 -517 and Manganese) reduced Underlying EBIT by Attributable Profit 13,416 15,390 10,722 US$2.5b. Copper sales volumes were impacted Exceptional items 259 22 -4,845 by lower ore grade and reduced output from Profit excl Exceptionals 13,675 15,368 5,877 milling operations at Escondida. Lower average realised prices (particularly for crude oil, copper, nickel, aluminium, alumina Underlying EBIT (US$m) 2007 2008 2009 and diamonds) reduced Underlying EBIT by Petroleum 3,014 5,489 4,085 US$4.0b. Aluminium 1,856 1,465 192 Costs increased by US$2.5b with the bulk of Base metals 6,875 7,989 1,292 the cost increases in the first half. Diamonds & Spec. Prod. 197 189 145 Discretionary costs previously incurred to Stainless Steel Materials 3,675 1,275 -854 maximise production to realise high prices were Iron Ore 2,728 4,631 6,229 reduced. The benefits of falling input prices (eg Manganese 253 1,644 1,349 caustic soda) will generally be lagged and Metallurgical Coal 1,247 937 4,711 realised from the current December half. Energy coal 481 1,057 1,460 Despite the recent strength in the A$ and the Group & unalloc. Items -259 -394 -395 Rand, exchange rate movements increased BHP Billiton (total) 20,067 24,282 18,214 Underlying EBIT by US$2.5b over the 2009FY. (a) Including impact of price-linked costs. Exceptional items totalled US$6,054b (pre-tax) and costs relating to the lapsed offers for Rio Tinto US$4,845b (after-tax). BHP had announced (in the (pre-tax charge: US$450m). interim results release in February 2009) the planned Net operating cash flow was up 6% to a record indefinite suspension and writedown of the US$18.9b, due to the strong December half Ravensthorpe Nickel Operation to zero (updated (US$13.1b). BHP’s cash flow priorities remain pre-tax impairment charges: US$3.615b), plus the unchanged – maintain the balance sheet, invest in BHP Billiton Ltd organic growth, participate in opportunistic mergers US$9.5b (2009: US$10.6b). If the proposed WA Iron and acquisitions and (then) return surplus cash to the Ore Joint Venture payment (US$5.8b prior to a shareholders. material adjustment) is added to this total, the spend is then comparable to the market capitalisation of Summary Cash Flow (US$m) 2008 2009 companies like Alcoa Inc. Operating cash flow & jv dividends 25,199 25,212 Net interest paid -630 -314 Summary Balance Sheet (US$m) 2008 2009 Tax paid -6,752 -6,035 Cash 4,237 10,833 Net operating cash flow 17,817 18,863 Inventory 5,203 5,021 Capital expenditure and financial investment -7,558 -9,492 Property, plant & equipment 47,332 49,032 Exploration expenditure -1,350 -1,243 Other 19,117 13,884 Purchases of investments -336 -593 Total Assets 75,889 78,770 Sale of fixed assets & investments 180 277 Interest Bearing Liabilities 12,695 16,419 Net cash flow before dividends & funding 8,753 7,812 Provisions 7,847 8,919 Dividends paid -3,250 -4,969 Other 16,304 12,721 Net cash flow before funding 5,503 2,843 Total Liabilities 36,846 38,059 Net Assets 39,043 40,711 The Group’s financial strength – gearing (net debt/net Gearing: Net Debt/(debt+equity) 17.8% 12.1% debt+equity) reduced to 12.1% at 30 June 2009 (30 EBITDA interest cover (excl exceptionals) 49.4x 56.8x June 2008: 17.8%) - had been a clear competitive advantage during the severe global economic Commodity Outlooks downturn. However, few Tier One assets became available during the global financial “squeeze” (the In China in particular, re-stocking coupled with apparent duration has been shorter than BHP stimulus package spending, fuelled strong real expected). This is relevant in the context of press and demand in key commodity-intensive industries such other commentary suggesting that BHP has missed as infrastructure, construction and real estate. The moving on acquisition targets during the global velocity of the recovery in commodity demand in financial crisis. Additionally, BHP’s planned capital China had surprised BHP (particularly where imports and exploration expenditure for the 2010FY is have replaced higher cost domestic production, eg in iron ore). After intensive de-stocking, there is emerging re-stocking or a combination of re-stocking and evidence of demand improving in North America, real demand”. Real demand following the stimulus Europe and Japan (again, re-stocking in Europe and spending will be the key to a sustainable price Japan has started a little earlier than BHP expected). recovery. Further improvements in commodity prices BHP has maintained its view that “it is too early to in the short term are likely to trigger supply tell whether this improvement is driven only by a responses from idle industry capacity. From current BHP Billiton Ltd levels, BHP does not expect significant price reaction In the long term, BHP continues to expect strong (ie further price rises) in response to improving commodity demand growth from China (and India). conditions in the short term. BHP/RIO Iron Ore Production JV benefits of the proposed transaction (as well as the arguments by the steel industry). On 5 December 2009, BHP Billiton and Rio Tinto signed binding agreements on the proposed Taking into account all regulatory review processes production joint venture covering the entirety of and shareholder approvals, BHP Billiton and Rio Tinto both companies' WA iron ore assets. now anticipate completion of the JV in the December half of 2010 (rather than earlier expectations of The companies have also filed submissions with the mid-2010). European Commission (EC) and the Australian Competition and Consumer Commission in relation to The production joint venture encompasses all current the proposed joint venture. The companies and future WA iron ore assets and liabilities and will understand that the EC will review the production be owned 50:50 by BHP and RIO. Both believe the joint venture under Article 101 of its merger rules net present value of the production and (formerly Article 81). This means it will be reviewed development synergies will be in excess of US$10 under the less onerous test of an operating joint billion (on a 100% basis; minority JV partners will venture, rather than a full function joint venture. marginally reduce the synergies realised by RIO/BHP). Whilst this is likely to increase the chances of the As previously outlined, these synergies are anticipated deal being approved, many groups have recently to come from: reiterated their opposition. Eurofer, the European Combining adjacent mines into single Federation of Iron and Steel Industries, has said that operations; the joint venture “will lead to unavoidable market concentration and increased pricing power, which is Reducing costs through shorter rail hauls and unacceptable in competition terms”. Eurofer, more efficient allocations of port capacity; Worldsteel and steel majors will argue that control of Blending opportunities which will maximise supply provides unacceptable market power. product recovery and provide further operating BHP and RIO had previously advised that both efficiencies; companies will market output separately - there will Optimising future growth opportunities through not be any joint marketing of iron ore (for 15% of the development of consolidated, larger and output - the only significant change since the initial more capital efficient expansion projects; and announcement on 5 June 2009). The proposed joint venture aims to produce more iron ore at lower cost Combining the management, procurement and with customers sharing some of the benefit. Under general overhead activities into a single entity. Article 101, the EC will have to consider these BHP Billiton Ltd We view the proposed production joint venture as 86% share in the Worsley alumina refinery in Australia. offering valuation upside for both BHP and RIO – Smelters: 100% in Bayside and Hillside smelters, South the synergy benefits would not currently be part of Africa; a 46% interest in the Alumar smelter, Brazil; a 47.6% stake in the Mozal aluminium smelter in base case valuations for either company. The Mozambique. market is obviously aware that any EC approval requiring infrastructure-related asset sales would Base Metals: Copper: Escondida mine Chile (57.5% int.); reduce the anticipated synergy benefits. wholly-owned Cerro Colorado. Antamina copper-zinc mine in Peru (33.75%), Olympic Dam SA, Cannington In order to equalise the contribution value of the two silver/lead/zinc mine Qld; the Spence copper project, Chile; companies, BHP will pay RIO US$5.8b for equity type proprietary bioleaching technology. interests at financial close (adjusted for respective Energy Coal: Largest producer of export steaming coal. cash contributions). Senior management of the Operations in South Africa (Ingwe, 100% owned), Australia entity will be determined jointly on merits with (100%, Mount Arthur North) & Colombia (33% in broadly equal participation from RIO and BHP. Carbones de Cerrejon ("CDC") & Cerrejon Zone Norte ("CZN")). Kalimantan Coal (80%), New Mexico, US (100%). Activities Stainless Steel Materials: Ferronickel: Cerro-Matoso, Colombia; Nickel/cobalt: Yabulu, Nickel West, Australia. BHP Billiton is a Dual Listed Company, comprised of BHP Billiton Ltd and BHP Billiton plc, which are separate legal Diamonds and Specialty Products: Ekati diamond mine, entities with separate share listings, managed on a unified Canada (80% int), Richards Bay Minerals (50%), basis. Exploration & Technology. Iron Ore: Mt Newman, Yandi, Mt Goldsworthy, Area C, Jimblebar in WA – all 85% int., Whyalla mines, Samarco, Brazil (50%). BHP Dividend History (2 Years) Date Paid Amount (c) Franking (%) Metallurgical Coal: Metcoal Holdings equally owned by 17/03/09 64.95 100 BHP Billiton & Mitsubishi; Central Queensland Coal 25/09/08 46.90 100 Associates (50%), Gregory (50%); BHP Mitsui Coal (80%); 18/03/08 31.94 100 Illawarra Collieries. 28/09/07 33.63 100 Manganese: Samancor (60% interest); Groote Eylandt Mining Co ("GEMCO) and Tasmanian Electro Metallurgical Company ("TEMCO”). Important Dates (Approx.) Petroleum: Bass Strait (50% interest), NW shelf (16.7% in Final Result Shares Ex-Final Final Dividend LNG phase, 8.3% domestic gas phase), Timor Sea Announced Dividend Paid (Laminaria/Corallina oil fields); Stybarrow (50%); Gulf of Mexico (various interests); Angostura; Liverpool Bay, UK 12 August 31 August 25 September (46.1%); Zamzama, Pakistan (38.5%); Ohanet, Algeria Half Year Result Shares Ex-Interim Interim Dividend (45%); ROD, Algeria (36%). Announced Dividend Paid Aluminium: Refineries: 36% interest in the Alumar 10 February 23 February 17 March refinery in Brazil; a 45% share in a refinery in Suriname; F.W. Holst & Co. Pty. Ltd. Rob Craigie This publication has been prepared by F W Holst & Co. Pty Ltd ABN 67 006 545 660 (“HOLST”) Australian Financial Services Licensee No. 247841 for its clients and must not be copied in any way or distributed to any other person without the written authorisation of HOLST. This publication provides general advice only and has not been prepared taking into account your financial situation, investment objectives and particular needs. Before acting on the general advice contained in this publication, you should obtain individual expert financial advice suitable to your needs and objectives. Nothing in this publication shall be construed as a solicitation to buy or sell or engage in or refrain from engaging in any transaction. The HOLST research analyst is responsible for the content of this publication and certifies that all of the views expressed reflect the analyst's personal views about the security at the time of writing. The opinions, forecasts and recommendations expressed are subject to change without notice. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the opinion, forecasts or recommendation expressed by the analyst in this report. HOLST, its directors and associates may hold an interest in financial products and may effect transactions, which may not be consistent with the recommendation in this publication. HOLST, its directors and associates may or has received brokerage, commission, fees or may receive other benefits on transactions and/or holdings in the financial products mentioned in this publication. HOLST has made every effort to ensure the information in this publication is accurate and takes no responsibility for any losses incurred as a result of any errors or omissions in data on which this document is based. Rob Craigie and/or associated parties own or have an interest in the securities of BHP Billiton Ltd and Rio Tinto Ltd.
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